Sunday, February 23, 2014

Despite its odd denomination, the above is a genuine banknote. Ne Win, Burma's military dictator from 1962 to 1988 and the man pictured in the note, was convinced that his lucky number was nine. So he had notes issued in multiples of nine, including the forty-five and ninety kyat notes (which also each add up to nine 4+5=9, 0+9=9). But I'll get to this story later.

This is a continuation of a post I wrote earlier describing how central banknotes aren't mere bits of intrinsically useless paper. The standard view among economists is that banknotes are bubble assets. Because they are intrinsically valueless, the fact that paper notes earn a positive value can only be explained by the fact that the market expects them to have value in the future, much in the way that a ponzi scheme or chain letter is perpetuated. This view goes back to Paul Samuelson (pdf), who described how a "grand consensus" might be arrived at whereby society could contrive to have "oblongs of paper" pass at a positive value from generation to generation. The creation of such a bubble would allow for an efficient allocation of resources. As long as each generation could fool itself into thinking that the next would accept these worthless bits of paper, the scheme could continue indefinitely.

However, if real life banknotes were in fact pure Samuelsonian bubbles, then no one would bother participating in central bank redenominations. If a central bank were to announce a 10:1 redenomination, why take in your $1000 note to be redeemed for a $100 note? After all, your existing $1000 note will buy you more stuff than a prospective $100. That we do take part in redenominations is due to the fact that the central bank is threatening to do something to its legacy note issue—it is threatening to cease honouring them as its liability, or IOU, an act sufficient to drive that notes' value to zero. This quality of a banknote as a liability or IOU means that a note is not a Samuelsonian asset.

That central banks offer legacy note conversion at all is another sign of the IOU-nature of bank notes. It explains why we don't see revolutions during redenominations and demonetizations. Those suddenly left holding old paper would riot on the streets upon the sudden displacement of their notes by a new currency. We don't see riots due to redenominations or demonetizations because banknotes aren't Samuelsonian—central bank paper carries an implicit IOU whereby the central banker will typically repurchase the legacy notes that they've issued at a fixed rate rather than letting those notes flap around in the wind.

For instance, when the European central banks ceased their issuance of domestic banknotes they didn't strand them. Rather, they offered a window in which individuals would convert legacy notes into euros. This window varied in size by country. In the case of the Banca d'Italia, for instance, lira could be converted into euros until February 2012, a ten-year window. De Nederlandsche Bank continues to offer to convert old Dutch guilders into euro, and will do so until 2032, while the Bundesbank, Banca D'Espana, and the National Bank of Belgium guarantee to perpetually redeem deutsche marks, pesetas, and francs respectively with euros. Here is a full list:

As a convertibility window narrows toward zero, a central bank's paper loses its IOU nature and approaches the ideal of Samuelsonian money. For instance, when Saddam Hussein decided to cancel the old "Swiss Dinar", he did so by offering note holders a tiny six-day exchange period, a mere crack compared to the massive windows left open by European central banks. Saddam narrowed this aperture even further by deviously shutting down the Iraqi border during the exchange period, preventing the large population of merchants in Jordan and elsewhere from crossing over into Iraq to swap their Swiss dinars for new dinars.

The Burmese kyat, pictured above, is another example of a note that approaches bubble money. In September 1987, Ne Win demonetized the largest denominations of kyat: the twenty-five, thirty-five, and seventy-five kyat notes, issuing in their place the aforementioned forty-five and ninety notes.

As dictator, Ne Win didn't seem to see any problem in burdening the Burmese population with these awkwardly-denominated notes. The legacy notes being replaced that September were already in odd denominations (25, 35, and 75), the hallmark of a redenomination in 1985 that replaced more conventional denominations of twenty, fifty, and one-hundred kyat notes. It seems that the seventy-five note was issued to mark Ne Win's 75th birthday, and the thirty-five replaced the fifty because it was, according to Ne Win's numerologist, the luckier of the two numbers.

To make matters worse, the legacy issue of kyat notes could not be converted into new forty-five and ninety kyat notes, effectively removing the IOU embedded in kyat notes and rendering a large part of the nation's stock of notes worthless. Here is an account of a Burmese individual at the time:

Then on September 5, without alerting even his cabinet, Ne Win passed a sealed envelope to the Information Minister. Inside were instructions to broadcast the enclosed announcement at 11:00 a.m.

I listened to the 1:00 p.m. news on the car radio outside the art exhibition. When the announcer said government employees would receive 450 kyats as emergency funding, I knew our kyat notes in denominations of 75, 35, and 25 had all been instantly devalued. At home that afternoon my family members gathered to pool our currency. Ko Gyi had received cash payment from a client on Thursday, all in 75-kyat notes, and I had not yet opened my two most recent pay envelopes, one containing my salary, the other my bonus, also dispensed in 75-kyat notes. My brother and I together had only 25 kyats in 10- and 5-kyat notes. Our other cash was useless.

Still hoping from compensation after the demonetization announcement in 1987, some people hoped to make a quick profit. Expecting a grace period, they started collecting 75 kyats by paying 50, then collecting 30 kyats for the same amount, then 20, until finally, when no follow up news came from the government, they realized they had lost everything. Two thirds of the total currency in circulation became useless paper, and ordinary citizens lost their entire savings. Even the beggars suffered. - No Time for Dreams: Living in Burma Under Military Rule, by San San Tin

Ne Win had contrived to create Sameulsonian money. Rather than greeting Ne Win's contrivance with open arms, popular uprisings began in 1988, eventually leading to Ne Win's resignation. Aung San Suu Kyi would emerge as an opposition leader in these uprisings.

North Korean won are a more recent example of notes devolving into mere "oblongs" of paper. In November 2009, the North Korean government announced a 100:1 redenomination. Nothing unusual here, except that North Koreans were given a seven-day window to convert existing Korean won into new notes. This window, already narrow, was further constricted by a ₩100,000 limit on the amount that could be converted. Given the then prevailing black market exchange rate of ₩3,000 to the dollar, the amount of legacy won that could be converted into new won was limited to around $30. Tragically, any North Korean who had won-denominated savings larger than that amount lost much of what they had.

Public anger forced the government to increase the limit to ₩150,000, but widespread uprisings as in the case of Burma never followed. The perception that future surprise redenominations might rob existing note holders has not promoted the stability of the won. Indeed, the inflation rate in North Korea is one of the highest in the world. Circulation of US dollars and Chinese yuan increased dramatically as a result of the redenomination, since no one fooled once wants to be fooled twice. (A shift to the use of the dollar also occurred in Burma as a result of Ne Win`s 1987 redenomination, as this interesting article points out.)

Though Samuelsonian money is an elegant idea, the reality is ugly. Only the most sinister dictators have tried to perpetuate it. The contrived currencies that have had Samuelsonian characteristics—Burmese kyat, North Korean won, and Saddam dinars—have been among the world's worst currencies. Widely accepted and long-lasting bank notes like dollars and euros are not bubble-like. Their issuers threat these as IOUs, much like a stock or a bond. If they fail to take these commitments seriously, say in the case of redenominations, their currencies will quickly be out-competed by currencies issued by banks that do.

For the past year or so, US dollars deposited at the MtGox bitcoin exchange haven't been considered to be particularly good dollars. The problem is that they are illiquid. Due to a number of reasons (see Konrad Graf),
MtGox
has limited the ability of users to convert
MtGox
dollars into conventional dollars issued by the likes of Bank of America, Wells Fargo, and the US Federal Reserve. Withdrawals are slow, uncertain, and red tape abounds.

Current holders of "bad"
MtGox
dollars would very much like to make their dollar-denominated wealth more liquid. Unfortunately the only reliable route available to them is to exchange their bad
MtGox
dollars for someone else's bitcoin via
MtGox's order book, then move these bitcoin off-exchange in order to purchase better and more liquid US dollars elsewhere. But why would a potential counterparty with spare bitcoin want to engage in this trade? After all, if they do then they'll only end up incurring the very same illiquidity risk that the original owner of
MtGox
dollars seems so desperate to offload. Better for the potential counterparty to sell their bitcoin for "good" (i.e. liquid) dollars at a competing exchange (like Bitstamp) that doesn't impose dollar redemption hassles.

In order for them to accept the burden of MtGox
liquidity risk, potential purchasers of
MtGox
dollars must be cajoled into the trade by the promise of a large discount. Owners of
MtGox
dollars eager for bitcoin need to mark down the price at which they are offering their
MtGox
dollars, or, conversely, they need to mark up the price at which they will purchase bitcoin relative to the price at which it trades on other exchanges.

This, in short, is the most likely reason for the historical premium of
MtGox
bitcoin over bitcoin on other exchanges like
Bitstamp and BTC-e
, or, conversely, the discount of
MtGox
dollars relative to dollars on other exchanges. See the chart below, which shows how the
MtGox
USD/BTC rate has historically traded at a discount to the Bitstamp USD/BTC trade. (Note that I've flipped the traditional bitcoin price chart upside down to emphasize the dollar-side of the equation). In short, because they are relatively illiquid,
MtGox
dollars can't purchase as many bitcoin as Bitstamp dollars can.

Now as our chart shows, things have dramatically switched around, with
MtGox
USD/BTC recently flipping to a massive premium over Bitstamp USD/BTC. I'll get to that in a bit, but before I do so let's imagine the opposite situation to the one outlined above, a limitation on bitcoin withdrawals from
MtGox. In this case things would tilt the opposite way. The only way to liberate wealth in the form of bitcoin from
MtGox
would be to buy
MtGox
dollars and withdraw them, then buy "good" bitcoin elsewhere. Counterparties would only agree to sell dollars for "bad" MtGox
bitcoin if they were offered a steep discount on those coins. The price of
MtGox
bitcoin would have to be marked down relative to elsewhere, or, conversely, the price of
MtGox
dollars marked up relative to dollars elsewhere.

Let's imagine another scenario. What if redemptions of *both*
MtGox
bitcoin and
MtGox
dollars were halted or at least slowed? Put differently, what if both are equally bad, or illiquid?

In this case, an owner of
MtGox
bitcoin would see no benefit in offering to buy
MtGox
dollars at a premium since those dollars would be just as illiquid as bitcoin. Nor would an owner of
MtGox
dollars have any incentive to buy
MtGox
bitcoin at a premium, since those bitcoin would be just as unmarketable as dollars. The upshot is that the
MtGox USD/BTC exchange rate would show neither a premium nor a deficit relative to the prevailing exchange rate on other markets.

However, the fact that we would no longer see any discrepancy in the
MtGox
USD/BTC exchange rate relative to the Bitstamp USD/BTC would not indicate that all is normal in the bitcoin universe. The freezing up of
MtGox
would reveal itself in a market we haven't considered yet: the
MtGox
USD/Bitstamp USD market. Presumably there is some sort of over-the-counter market on which trusted individuals directly swap the dollar deposits of one exchange for another. With
MtGox
freezing all withdrawals, we'd expect this exchange rate to be trading at a large deficit, investors willing to pay a much higher price to own liquid Bitstamp dollars. The same goes for the
MtGox
BTC/Bitstamp BTC market. Normally, this market would trade at par, since a bitcoin held on one exchange should be no different from a bitcoin at another. However, with
MtGox
frozen up investors would probably prefer to own liquid Bitstamp bitcoin and would pay a much higher price to do so.

Now let's get back to the inversion we see on our chart. There's been some interesting news in the bitcoin universe. It appears that
MtGox
bitcoin withdrawals have been halted, adding to the already-existing liquidity problems facing
MtGox
dollar owners. Peter Šurda gives more details here. As I pointed out above, if both bitcoin and dollars at
MtGox
have now been rendered equally illiquid then the
MtGox
USD/BTC ratio should not vary from prevailing USD/BTC ratio at exchanges like Bitstamp and BTC-e.

But what we've actually seen is a huge rise in the
MtGox
USD/BTC ratio relative to that of Bitstamp. The discount has become a premium. This would seem to indicate that though
MtGox
dollars are still relatively illiquid, they are more liquid than now-frozen
MtGox
bitcoin. Those with bitcoin-denominated wealth stuck in
MtGox
desperately want
to trade "terrible" MtGox bitcoin for "less terrible" MtGox dollars in order to flee. They are offering an incredibly high USD/BTC rate to tempt counterparties into taking the opposite—and more illiquid—side of this trade.

Now before you start shaking your head about the strangeness of modern cryptocurrency markets—"how weird is it to have multiple prices for the same money!" —note that we've seen this all before. In the first half of the 19th century, there was a bewildering quantity of different US dollar banknotes, with thousands of banks issuing their own brand. Prior to accepting a certain bill from a customer, a shopkeeper would consult his weekly Bank Note Reporter to determine what sort of discount or premium he should attach to the note.* (See the picture at top). In those days, notes were universally redeemable in a certain quantity of gold. What made things tricky was the fact that redemption could be easy or difficult, depending on how far away the issuing bank was. A note issued by a bank based in rural Pennsylvania and spent in South Carolina would have to take a circuitous and potentially expensive route back to its issuer prior to being cashed in for the metal. This resulted in those notes earning a higher discount. One dollar, multiple prices, was the norm back then.

Now compare
MtGox
to our rural Pennsylvanian bank. Given the long and circuitous route that both the banknote and the
MtGox
dollar must take prior to being "cashed out", they both trade at a large discount. Once again we have one dollar but multiple prices. Everything old is new again, it would seem.

Sunday, February 16, 2014

I'm going to use a stock market analogy to work out the costs of manufacturing liquidity premia.

In addition to paying dividends and providing price appreciation, stocks provide an amenity flow in the form of expected exchangeability, or liquidity. Like any other consumption good & service, the provision of such an amenity requires an outlay by the supplier. In the same way that a widget producer won't sell widgets below marginal cost, the marginal seller of stock, the issuing firm, won't manufacture new liquidity if the cost of production exceeds the benefits.

Say that a firm can hire an entire investor relations department for next to no cost. The IR team, full of eager promoters, will double the price that the marginal investor is willing to pay for the liquidity services thrown off by the firm's stock. They go about improving the stock's liquidity services by evangelizing the firm's "story", thereby widening the base of investors who deal in the shares. They make it easier for investors to hop in and out of the market.

The firm can now issue new stock at a much higher price thanks to its swollen liquidity premium. It invests the proceeds of new issuance at the risk-free rate of return. The firm has succeeded in getting something for nothing—at no cost to itself it has increased earnings-per-share. By issuing more shares the firm can continue to earn these extra-normal returns, at least until new issuance has satiated investor demand for liquidity and driven the firm's liquidity premium back to its previous level, at which point the strategy will have exhausted itself. New stock issuance will no longer increase per-share earnings.

Of course, investor relations teams can't be hired for nothing. If firms could perpetually increase earnings per share by costlessly boosting their liquidity premium and issuing new shares, then everyone would be doing it. In general, the price of hiring an IR team should be set such that it just offsets the benefits of the increase in a firm's liquidity premium. If the cost is lower, then firms will all try to purchase IR services in order to enjoy extra-normal profits, driving IR costs higher until the window for extra-normal profits has been closed. If the cost is higher, then firms will fire their IR department, the benefits of the liquidity premium manufactured by the IR department not justifying the expense of paying their salaries. In this case, IR costs will retreat until firms once again see some advantage in trying to hire an IR department to generate liquidity premia.

In short, the price that investors pay to enjoy a liquidity premium will be competed down to the IR costs of producing that premium.

Incurring IR costs are not the only way to do encourage liquidity. Relationships with market makers, dealers, and investment banking research departments will also help boost liquidity premia. Illegal practices like wash-trading can do the trick too.

Keep in mind that there are also large network effects at play. Incumbent stocks that have enjoyed high liquidity premia for decades will remain locked into that position, even if the incumbent's CEO were to fire the entire IR department. Liquidity is sticky. It would take incredibly large marketing outlays for a small rookie stock to displace an incumbent like IBM from its superior liquidity position.

If you get the chance, try visiting ten or twenty websites of publicly-traded companies and note how fancy each IR section is. Some will have only bare-bones text (like Berkshire Hathaway), others will have incredibly fancy flash animation and gorgeous pictures (like any junior gold miner).

These websites will give you some sense for each firm's pool of potential projects and respective strategy. Firms with a plenty of high-yielding investment opportunities will see no benefit in allocating funds to boost their liquidity premium. These sorts of firms will generally have ugly IR sections. Firms with fancy IR websites, on the other hand, have presumably measured all potential investment opportunities and decided that the highest yielding one is to hire aggressive IR so as to boost their liquidity premium, subsequently floating new shares. Investors who value liquidity on the margin would do well to gravitate to firms that see value in manufacturing liquidity premia. If you want liquidity, then buy from the people who make the stuff. Those investors who prefer pecuniary returns rather than liquidity returns should always avoid firms with fancy IR pages. After all, why buy liquidity if you don't value it?

The boundary case of firms pursuing higher liquidity premia are penny stock promotes. These firms have no real underlying business. Their only purpose is to create a temporary liquidity premia, the insiders exiting before those premia collapse to zero.

The general principles behind the manufacturing of liquidity premia described above apply not just to stocks, but to bonds, bitcoin, gold, cars, land, banking deposits, and all sorts of other assets. As long as people face uncertainty, they will always want to own liquidity. Those skilled in the manufacturing of this liquidity—marketers, salespeople, investor relations execs, promoters, bankers, and evangelizers—will always find their talents in high demand.

Sunday, February 9, 2014

In general, the real price of land has been increasing all over the world, especially since the early 1990s. (Japan and Germany are the exception). The recent credit crisis hurt this trend in a few countries like Ireland, Spain, Netherlands, and the US, but in other countries like Belgium, Canada, Sweden, and Australia the secular rise in housing prices remains intact.

A popular explanation for the rise in land prices are the various versions of the secular stagnation thesis advocated by folks like Paul Krugman and Larry Summers. According to Krugman, if the natural rate of interest has become persistently negative—i.e. new capital projects are expected to yield a negative return—then investors will look to existing durable assets like gold or land that yield no less than a 0% return. The prices of these goods will be bid upwards, bubble-like. Or, as Summers puts it, if the return on capital is below the economy's growth rate, then intrinsically valueless ponzi assets may be recruited as stores of value to bridge the distance between an individual's present and the future. (Krugman and Summers's ideas are a bit hard to follow, but Nick Rowe has a bunchofhelpfulposts on these ideas).

In short, these theories explain the paradoxical conjunction of bubbles with a sluggish economy and low inflation.

I think that a better explanation for the rise in real land prices is the emergence of large liquidity premium on land. This premium isn't an irrational "bubble" phenomenon. Rather, over the last decade or two finance and real estate professionals have put in large amounts of time, sweat, and tears to improve the underlying infrastructure that facilitates the transfer of residential land. A few of these improvements include the optimization of the mortgage lending process by the adoption of automated underwriting systems, the development of mortgage scoring, higher loan-to-value ratios on mortgage loans, and the creation of the mortgage-backed securities market.

All these improvements mean that your parcel of land is not like your grandfather's parcel—it can be sold off, parceled up, rented out, collateralized, and re-hypothecated faster than ever. In short, land has become more like cash. Whereas in the past the purchase of a house made you dramatically less liquid, these days that same house impairs your liquidity position much less.

Like any other asset owner, land owners expect to enjoy three services: a pecuniary return such as capital appreciation, a non-pecuniary consumption yield, and liquidity services. In a world in which arbitrage ensures that all assets provide roughly the same return, any improvement in the liquidity services provided by land reduces the amount of capital appreciation people expect to earn on their land parcel (we'll assume the consumption return is constant). This reduction in expected capital appreciation comes about via a rise in land prices now relative to their expected future price. So the steady improvements in the liquidity services thrown off by land have created a stepwise rise in land prices. This rise might appear to be a bubble, but it's only the market's warm response to the finance industry's consistent upgrades to the mechanisms that facilitate transfers of land.

If you believe John Maynard Keynes, what we're seeing now is just a reversion to ancient times. In Chapter 17 of his General Theory, Keynes wrote: "It may be that in certain historic environments the possession of land has been characterized by a high liquidity-premium in the minds of owners of wealth..." He goes on to note that the high liquidity premiums formerly attaching to the ownership of land are now attached to money. It may be the case that in modern times these liquidity premia are detaching from traditional forms of money like deposits and returning to land, the evidence being the rise of land prices and decline in traditional deposit banking.

When a market bursts, the stagnation thesis has it that people have spontaneously switched from one bubble to a new one, or that the underlying features of the economy (i.e the negative natural interest rate) have changed. If land price increases are being driven by improvements in liquidity services rather than low-to-negative rates of return and resulting bubble-seeking behavior, than snap-backs may occur when the underlying architecture supporting that liquidity fails. Alternatively, different networks of finance professionals may be working hard to build up their own asset's liquidity, thus competing away the liquidity premium of the incumbent asset.

Here's an interesting data point: While almost every western nation experienced a housing price boom between the mid 1990s and 2008, Germany somehow missed the boat.

Was Germany somehow exempt from the stagnation that other Western nation's face? Perhaps Germans selected a different bubble asset than land? Or did the underlying mechanics governing the liquidity of the German market for residential land stay constant whereas those of most nation's improved?

We know that while MBS markets were deepening all over the world, German law did not permit MBS issuance until 1997, putting it far behind the mortgage slicing & dicing eight-ball. Rather, German residential real estate finance continued to be underpinned the centuries old pfandrief, or covered bond. While the originator of an MBS can parcel away mortgages into a bankrupt-remote entity, the assets underlying a pfandriefe are required by law to stay on the issuer's balance sheet. The mortgages comprising MBS often have up to 100% loan-to-value ratios, but German law requires that pfandbriefe be backed by mortgage loans with a maximum of 60% of the home's "lending value" (lending value is more conservative than market value), which in practice means that Germans often have to put up 60-70% cash to buy a home. Such high requirements would surely stifle the liquidity of residential land, especially compared to places like Canada where permitted LTVs went from 80% to 100% in the space of ten years.

So while Keynes's liquidity premium may have migrated back to land in much of the western world, this doesn't seem to be the case in Germany. There are surely advantages to having avoided a rise in housing prices. On the other other hand, owning a liquid house rather than an illiquid one is a boon—it provides an individual with a fluid asset for dealing with an uncertain future. From this perspective, any attempt to stifle some asset's liquidity by limiting the finance industry's ability to innovate reduces the range of coping mechanisms that a society is presented with.

P.S. I already wrote versions of this post. Here are these ideas applied to equity markets, here they are applied to bond markets. Same idea, different day, different market.

Sunday, February 2, 2014

2010 Bank of England note signed by Andrew Bailey, former Chief Cashier of the Bank.

A few years ago, Peter Stella and Åke Lönnberg conducted a study that classified national banknotes by the signatories on that note's face. They found some interesting results. Of the world's 177 banknotes with signatures (10 had no signature whatsoever), the majority (119) were signed by central bank officials only. Just four countries issue notes upon which the sole signature was that of an official in the finance ministry: Singapore, Bhutan, Samoa, and (drum roll) the United States.

Stella and Lönnberg hypothesize that the signature(s) on a banknote indicate the degree to which the issuing central bank's is financially integrated with its government. The lack of a signature from a nation's finance ministry might be a symbol of a more independent relationship between the two, the central bank's balance sheet being somewhat hived off from the government's balance sheet and vice versa. The presence of a finance minister's signature would indicate the reverse, that both the treasury and central bank's balance sheets might be best thought of as one amalgamated entity.

The nature of this arrangement is significant because if something disastrous were to happen to an independent central bank's financial health, say its assets were destroyed and all hope of profits dashed for eternity, the central banker should not necessarily expect support from his/her government. Lacking in resources, monetary policy could go off the rails. (Why would it go off the rails? Here I go into more detail).

On the other hand, should it be established by law that a government is to backstop its central bank, that same disaster would pose a smaller threat to monetary policy since the nation's finance minister, his John Hancock affixed to the nation's notes, would presumably come to the central bank's rescue.

These ideas are similar to Chris Sims's classification of type F and type E central banks (alternative link). One of the features of type F banks (like the Fed) is that "there is no doubt that potential central bank balance sheet problems are nothing more than a type of fiscal liability for the treasury." On the other hand, with type E banks (like the ECB) "it is not obvious that a treasury would automatically see central bank balance sheet problems as its own liability."

So is it the case that the Federal Reserve is actually more fused with the U.S. Treasury than other central banks are? One reading of the Federal Reserve Act might indicate yes. Section 16.1 stipulates that Federal Reserve notes are ultimately obligations of the US government:

Federal reserve notes, to be issued at the discretion of the Board of Governors of the Federal Reserve System for the purpose of making advances to Federal reserve banks through the Federal reserve agents as hereinafter set forth and for no other purpose, are hereby authorized. The said notes shall be obligations of the United States and shall be receivable by all national and member banks and Federal reserve banks and for all taxes, customs, and other public dues.

The language in the above phrase would seem to indicate that should the Fed find itself incapable of exercising monetary policy (Stella and
Lönnberg
use the term policy insolvency), the US government is obliged to step in and make good on the Fed's promises, however those promises might be construed. The fact that Treasury Secretary Jacob Lew's signature appears on all paper notes, as does that of U.S. Treasurer Rosa Gumataotao Rios, can perhaps be taken as an indication of this guarantee.

Bank of Canada notes, on the other hand, are signed by the Governor of the BoC and his deputy. Finance Minister Flaherty's signature is nowhere in sight. This jives well with a quick reading of the Bank of Canada Act, which stipulates that though notes are a first claim on the assets of the Bank of Canada, the government itself accepts no ultimate obligation to make good on banknotes. In theory, should the Bank of Canada cease to earn a profit from now to eternity, Canadian monetary policy could go haywire—American monetary policy, backstopped by the Treasury, less so.

Other central banks go even further in formalizing this separation. In Lithuania, for instance, the law states that: "The State of Lithuania shall not be liable for the obligations of the Bank of Lithuania, and the Bank of Lithuania shall not be liable for the obligations of the State of Lithuania." Should Leituvos Bankas hit a rough patch, so will its monetary policy.

Stella and Lönnberg correlate the rise of independent central banking with a movement away from the printing of finance minister signatures on notes. For instance, the sole signature on Euro banknotes is that of the President of the ECB, Mario Draghi. Two of the currencies replaced by the Euro, the Irish punt and the Luxembourg franc, which had carried signatures of finance department officials, no longer exist, symbolic evidence of the Euro project's dedication to central bank independence.

Sims uses the ECB as an exemplar of type E central banks because "the very fact that there is a host of fiscal authorities that would have to coordinate in order to provide backup were the ECB to develop balance sheet problems suggests that such backup is at least more uncertain than in the US." For evidence, he points to the fact that the Fed carries just 1.9% of its balance sheet in capital and reserves while the ECB holds 6.7%.

Stella and Lönnberg hint at the prevalence of a "rather singular U.S. view of central bank and treasury relations." My interpretation of this is that most conversations about central banking are inherently conversations about the the world's dominant monetary superpower, the Federal Reserve. This is surely evident in the blogosphere, where we mostly talk as-if we were Bernanke, not Carney or Poloz or Ingves (Lars Christensen is a rare counter-example who is fluent in multiple "languages"). In the same way that all Americans only understand English while all foreigners are conversant in English and their native tongue, non-American commentators like me can't talk solely in terms of our own central bank (in my case the Bank of Canada) lest we fall out of the conversation. The Fed becomes our focal point.

Yet among central banks, the Fed is an odd duck, since the wording in the Federal Reserve Act and the signature on its notes would indicate a more well-integrated financial relationship between central bank and treasury than most. The upshot is that popular conceptions of the central banking nexus will often be wrong as they will be couched in terms of the U.S.'s integrated viewpoint, whereas most of the world's central banks are not structured in the same way as the U.S. A deterioration of the Fed's balance sheet would likely be neutral with respect to monetary policy, but for many of the world's nations this simply isn't the case.

On a totally unrelated side note, I found it interesting that Bank of England notes stand out as being signed by the Chief cashier of the Bank, not the governor. When the BoE opened its doors for business in 1694, the banknotes it issued were written on blank sheets of paper, often for unusual quantities (standardized round numbers were not introduced till the 1700s). The bank's directors and its governor, usually well-established bankers who simultaneously ran their family business, were not responsible for the BoE's day-to-day operations, this being devolved to the bank's cashiers who were given the repetitive task of signing each note by hand. Even when the ability to print signatures directly on to notes was developed in the 1800s, the practice of affixing the cashier's signature continued, despite the fact that mechanical process would make it easy for the higher-ranked governor to get his name on each note.

So while Mark Carney's route from the BoC to the BoE got him a higher salary, more prestige, and posher digs, in one respect his standing has deteriorated: there are no longer millions of bits of paper circulating with his name on them. Chief cashier Chris Salmon has that distinction.

PS: You should try and read all of Peter Stella's papers. They are excellent. He blogs here.